The Silver-Gold Correlation Fell To A New Low

|
 |  Includes: PAAS, SLV, SLW
by: Lior Cohen

Summary

Silver has had a weak correlation with gold in the past few weeks.

Silver weakened during most of August.

The upcoming U.S GDP report could move silver.

The price of silver continued to decline last week. Since the beginning of the month, silver lost 5% of its value. The changes in the foreign exchange market or gold seem to have little impact on silver. What could keep dragging down silver?

Last week, silver lost 0.7%. The silver ETF iShares Silver Trust (NYSEARCA:SLV) fell by 0.9%. Further, major silver related companies such as Silver Wheaton (NYSE:SLW) and Pan American Silver (NASDAQ:PAAS) dropped last week by 2.7% and 0.9%, respectively.

The main event from last week was the Jackson Hole symposium. There were no surprise from Yellen in here speech. She said there is still slack in the labor market. Nonetheless, she still left the door open for a rate hike at sooner than anticipated timing:

"But if progress in the labor market continues to be more rapid than anticipated by the Committee or if inflation moves up more rapidly than anticipated, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target could come sooner than the Committee currently expects and could be more rapid thereafter".

This wording isn't new but still leaves the possibility that FOMC may raise rates by the first quarter of 2015. The next FOMC meeting next month could offer some more information on this issue. Until then we should take note of the weakening of the relation between gold and silver.

Silver and gold

Despite the strong relation silver has had with gold throughout the years, the two precious metals had a "falling out" in the past month, as the linear correlation between their prices have dropped to its lowest level in years, as indicated in the chart below.

Click to enlarge

Source: Bloomberg

Moreover, even though gold lost nearly 2% of its value last week, it's nearly flat for the month. The price of silver, however, is down by 5%. We need to consider several factors when examining the weak correlation silver has had with gold in the past few weeks:

  1. Silver is considered by many a poor man's gold for those seeking to invest in precious metals. So, in a way they are like substitute goods. Even though they are not perfect substitute (for investment purposes), sliver tends to follow gold. If precious metals are expected to come down, silver is likely to lead the way and pull back first and at faster pace.
  2. The price of silver tends to have a stronger volatility than gold. This could also suggest short term sharp swings.
  3. The silver market is smaller than the gold market, which may also open the door for more speculative moves by big players. Gold also has a strong demand by financial institutes and central banks, which keeps its demand robust even when investors steer away from the yellow metal;
  4. This is a short term reaction: We have to remember that the current low correlation between gold and silver, which currently stands on 0.459, is only for a relatively short period of time. In time series these drops could occur and don't necessarily mean a change in a trend.

So, we should only take this figure into account and put it on notice. It's still too early to consider a major shift in the relation between gold and silver, but this also serves as a reminder for the potential fragile relation these two metals may have at times.

Silver and U.S dollar

The silver market also has been having a weak relation with the USD as indicated in the chart below.

Source: Bloomberg

In the past several weeks the U.S dollar has mostly appreciated against the euro, yen and Canadian. The chart above suggests the movement of the USD against other leading currencies seem to have had little effect on the silver market. Thus, even if the USD continues to rally, it will have a modest impact on silver.

Looking on this week, we have two major reports in the U.S, the GDP second quarter estimate, and the PCE for June.

In the past update, the GDP expanded by 4% in the second quarter. This came after the US economy shrank by 2.1% in the first quarter. The current estimates are that the GDP will reach 3.9%. If the GDP update shows any significant change from this estimate, and silver prices could react to this news.

The PCE is another indicator the FOMC likes to follow in determining the progress in the U.S inflation.

Source: Bloomberg and Bureau of Economic Analysis

As you can see, the PCE has rallied in the past few months, but it didn't seem to have much of an impact on silver. But if the PCE continues to rise, this will raise the chances of the FOMC hitting the rate hike button sooner rather than later. This rate hike could have a negative impact on the silver market.

Final note

Silver hasn't performed well in the past few weeks, and is more likely to come down in the near term. But this doesn't mean we couldn't see short term rallies especially considering the recent apparent detachment silver has had with gold and USD. For more see: Silver Outlook for August 25-29

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.